A Cash Balance Pension Plan is a type of defined benefit pension plan that combines some of the features of both traditional defined benefit plans and defined contribution plans. In a cash balance plan, employees have individual accounts with a stated “cash balance,” which grows with each year’s contributions and interest credits. Here are the key features and components of a cash balance pension plan:
1. Individual Accounts: Each participant in a cash balance plan has an individual account, much like in a defined contribution plan. This account is often referred to as a “cash balance account” or “hypothetical account.”
2. Contributions: Contributions to cash balance accounts are made by the employer, and the contribution is based on a percentage of the employee’s compensation. The contribution is deposited into the employee’s cash balance account.
3. Interest Credits: The cash balance account grows annually through interest credits, which are applied to the account’s balance. The interest rate used is typically set by the plan and can be a fixed rate or based on a benchmark, such such as the yield on Treasury bonds.
4. Guaranteed Benefit: Although participants have individual accounts with stated cash balances, the plan still guarantees a specific retirement benefit based on the cash balance. The benefit is the total cash balance in the account at retirement, which can be converted into a lump-sum distribution or an annuity.
5. Vesting: Cash balance plans typically have vesting requirements, which determine when participants have a non-forfeitable right to the employer’s contributions. Vesting schedules can vary, but they are often shorter than in traditional defined benefit plans.
6. Retirement Age and Withdrawals: Participants can generally choose when to start taking distributions from their cash balance accounts, which can be as early as age 59½ without penalties. Some plans also offer the option of annuitizing the cash balance.
7. Investment Risk: Cash balance plan participants do not bear direct investment risk. The interest credits are typically based on a predetermined rate, which is set by the plan, regardless of the actual performance of investments.
8. Portability: Cash balance plans are generally more portable than traditional defined benefit plans. When changing jobs, participants can often choose to roll over their cash balance into another qualified retirement account.
9. Regulatory Oversight: Cash balance plans are subject to government regulations, including contribution limits, nondiscrimination rules, and required minimum distributions (RMDs).
10. Survivor Benefits: Cash balance plans may provide survivor benefits, which ensure that a portion of the cash balance account continues to a surviving spouse or beneficiary in the event of the participant’s death.
11. Tax Benefits: Contributions to cash balance plans made by employers are often tax-deductible. Account balances grow tax-deferred until distributions are made in retirement.
12. Employer Contributions: Employers are responsible for contributing to participants’ cash balance accounts, and these contributions are mandatory based on the plan’s terms.
Cash balance plans offer participants the advantages of a guaranteed retirement benefit, like a traditional defined benefit plan, along with some of the features of individual accounts and portability seen in defined contribution plans. These plans have gained popularity in various industries and are often used by employers looking to provide retirement benefits while offering more flexibility and predictability in plan funding.